Are Dividend Payers the New Growth Stocks?

by Nancy Zambell | January 23, 2012 9:00 am

Adding dividend-paying stocks to your portfolio helps you hedge against inflation and can also boost your returns in a down market cycle. This is crucial to a well-balanced portfolio — the fourth step I cited in my article last week, 5 Steps to Protect Your Portfolio[1].

Many newbie investors and younger folks often neglect this step since they’re focused on gleaning maximum returns from their portfolios, which generally means buying lots of high-growth stocks.

However, what goes up also comes down, and when the market cycle turns bearish — or even sideways — owning a few dividend stocks can turn a losing portfolio into a winning one.

I can’t really blame investors for thinking that stocks that pay dividends only represent old, stodgy companies because that’s the way it used to be. But in today’s world, more and more companies are paying dividends to entice and reward their investors — even tech companies that wouldn’t have been caught dead paying dividends 10 years ago!

Consequently, investors today can find both growth and dividends in many stocks. Even better news: S&P recently reported that dividend increases are gaining momentum, growing to $50.2 billion last year — almost double 2010’s $26.5 billion rise.

Moreover, S&P forecasts additional double-digit growth in dividend payments this month and next, setting the stage for a potential record $252 billion paid out in 2012. That’s an 18% increase in the dividend rate, which can really ratchet up your portfolio’s returns.

To further prove my point that every investor needs some dividend stocks: Although we saw extreme market volatility in the last half of 2011, with the market averages barely eking out a return at all, dividend-paying stocks did more than O.K. According to Birinyi Associates, the 100 highest-yielding stocks in the S&P 500 Index rose an average of 3.7%, while the 100 lowest-yielding stocks declined an average of 10%. See what I mean about portfolio protection?

There are more than 7,000 dividend-paying stocks to choose from, with the highest yields generally found in telecommunications, utilities and health care, which averaged 2011 yields of 5.86%, 4.13% and 3%, respectively, S&P reports.

You can also find plenty of companies that are paying double-digit dividends.

But before you go chasing the highest yields, you should know that really high yields have two characteristics that investors need to fear:

The yields can fall really fast when interest rates or economic conditions change, as often occurs with mortgage real estate investment trusts (REITs), for example.

The highest-yielding companies often come with significant fundamental risks, and that’s why they reward investors with large payouts. Some energy and mining partnerships are good examples of speculative investments that may pay significant dividends.

That doesn’t mean you can’t put high-yielders in your portfolio. It just means you’ll need to keep a close eye on them to ensure that you sell them before the yields radically change — which they most likely will.

If you think of extremely high-yielding stocks the same way you might consider a “hot growth” stock — pretty neat for the short-term, but don’t fall in love with it for the long run — you should be able to manage a couple in your portfolio, reaping the rewards of the high yields, at least for awhile.

But there are thousands of stocks that pay 2%, 3%, or even 4% — middle-of-the-road payouts — that would be a tremendous asset to your holdings. And many of those are solid, fundamentally strong businesses that you can add to your portfolio and not worry too much about how temporary economic changes may affect them.

In my article earlier this week, Portfolio Protection Step 3: Diversification[2], I mentioned a few dividend payers for your consideration.

Today, I’m going to give you a few higher-yielding companies to consider — stocks that look both technically and fundamentally strong right now: